Employee Shareholders and Restrictive Covenants

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Employee Shareholders and Restrictive Covenants

The High Court has recently revisited the application of restrictive covenants in shareholders’ agreements to employee shareholders in the case of Eville & Jones (Group) Ltd & Anor v Aldiss & Ors [2022] EWHC 269 (QB).

Dr Aldiss was employed as a joint managing director of Eville & Jones (G.B.) Limited and held a 5% shareholding in its parent company. Despite only having a modest shareholding, he had signed up to a shareholders’ agreement containing some standard post-termination covenants. Those covenants restricted a shareholder from carrying on a competing business, soliciting customers, dealing with customers and soliciting employees. Eville & Jones argued that following Dr Aldiss’ dismissal as an employee, he had breached the restrictive covenants set out in the shareholders’ agreement.

The reasonableness of the restrictive covenants was questioned by Dr Aldiss for the following reasons:

  • he was an employee of Eville & Jones and was employed before becoming a shareholder.
  • he was only a minor (5%) shareholder of Eville & Jones and as a result he had the same inequality of bargaining position of many employees, whom the court protects.
  • the shareholders' agreement was not negotiated between commercial parties and had been presented to Dr Aldiss who felt that he had no real choice but to sign it without having taken legal advice and without being given the opportunity to do so.

As such the Court was invited to approach this case with the vigilance more akin to an employment contract, notwithstanding that the restrictions were contained in a shareholders’ agreement.

Why was Dr Aldiss taking this approach? All restrictive covenants in restraint of trade are, as a starting point, unenforceable at common law unless they are reasonable. The Court of Appeal recently confirmed in the case of Guest Services Worldwide Ltd v Shelmerdine [2020] EWCA Civ 85 that the court is less vigilant in terms of assessing reasonableness where restrictive covenants are contained in a shareholders' agreement, rather than an employment contract. In effect, the Court was being invited by Dr Aldiss to assess the reasonableness of covenants in a shareholders’ agreement applying the same standard as would be the case had the covenants been contained in an employment contract.

Despite his submissions, the Court found that Dr Aldiss had no reasonable prospect of successfully challenging the reasonableness of the covenants in the shareholders’ agreement.

This case adds to the existing caselaw that restrictive covenants in a shareholders’ agreement will not be subject to the same scrutiny as those in an employment contract and that employees who have signed a shareholders’ agreement will face an uphill battle if they ask the Court to treat those covenants in the same way as covenants in an employment contract.

Incentivising employees with a shareholding is common, but it creates opportunities and challenges. JMW has experts in drafting shareholders’ agreements and advising on employee incentivisation. Employees that are offered shares and invited to sign a shareholders’ agreement should consider any restrictions carefully and seek legal advice.

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